Finance and Economics Discussion Series

Financial Integration, Entrepreneurial Risk and Global Dynamics

Vasia Panousi and George-Marios Angeletos
2010-54

Abstract:
How does financial integration impact capital
accumulation, current-account dynamics, and cross-country
inequality? This paper investigates this question within a
two-country, general-equilibrium, incomplete-markets model that
focuses on the importance of idiosyncratic entrepreneurial
risk---a risk that introduces, not only a precautionary motive for
saving, but also a wedge between the interest rate and the
marginal product of capital. Our contribution is then to show that
this friction provides a simple explanation for the emergence of
global imbalances, a simple resolution to the empirical puzzle
that capital often fails to flow from the rich or slow-growing
countries to the poor or fast-growing ones, and a distinct set of
policy lessons regarding the intertemporal costs and benefits of
capital-account liberalization.